Buybacks Will Dry Up When The Next Recession Hits, Exacerbating The Eventual Bear Market

The bull market in the S&P 500 since March 2009 has been
marked by corporations buying back their shares and paying out
dividends. From Q1-2009 through Q1-2014, S&P 500 companies
repurchased $1.9 trillion of their shares and paid out $1.3
trillion in dividends. During the first quarter of this year,
buybacks totaled $637 billion at an annual rate, nearly matching
the previous record high during Q3-2007.

As I have often observed in the past, corporations have an
incentive to borrow in the bond market and use the proceeds to
buy back shares when their earnings yield exceeds the corporate
bond yield. That’s been the case since 2004 thanks to the Fed’s
easy monetary policies under both Alan Greenspan and Ben
Bernanke, and now Janet Yellen.

Buybacks are a form of financial engineering since they boost
earnings per share whether a company’s fundamentals are improving
or not. They’ve certainly contributed to the bull market’s great
run in an economic environment that has been widely described as
“subpar.”

When the next recession hits, corporate cash flow will decline
and investors are likely to be less willing to buy corporate
bonds. As a result, buybacks will dry up as they did during 2008,
exacerbating the eventual bear market in stocks.